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Many investors have large allocations to fixed income, and their portfolios have therefore suffered considerably in the current higher-inflation, higher-interest rate environment.
George Lucaci, global head of distribution at FolioBeyond, joins Andy Hagans to discuss the case for rising rate strategies and his firm’s ETF, RISR.
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- Background on George’s career, and how he got started in finance.
- Why every investor and advisor should consider including a rising rates strategy allocation in their overall portfolios.
- How the Silicon Valley Bank crisis may be a “canary in the coal mine.”
- Why George believes interest rates may remain higher for the foreseeable future.
- How RISR (FolioBeyond Rising Rates ETF) performed over the past twelve months, vindicating the thesis behind it.
- How all kinds of investors, from institutional to individual investors, can add a rising rates strategy to their portfolio.
Featured On This Episode
- RISR – FolioBeyond Rising Rates ETF (FolioBeyond)
Today’s Guest: George Lucaci, FolioBeyond
- FolioBeyond – Official Website
- FolioBeyond – For Individual Investors
- FolioBeyond on LinkedIn
- George Lucaci on LinkedIn
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to “The Alternative Investment Podcast.” I’m Andy Hagans. And today we’re talking about generating alpha with a rising rates strategy. There’s a lot going on in the world, right? Brings to mind the ancient Chinese curse, “may you live in interesting times.” George, I think we’re in interesting times right now. Is that fair?
George: We are certainly in interesting times. This is something that we hoped would never happen again, the recent debacle in the regional banks, but we could talk about that. Let me give you a quick background on myself. Spent 35 years in the financial markets.
Andy: George, George, sorry to interrupt. I didn’t even give our audience your name. George Lucaci, Global Head of Distribution at FolioBeyond. Sorry. I have to introduce my guests, so, let me start with that. So, this is George, everyone. Give us your background. How did you get into before we get into everything crazy going on in the world, where did it start for you?
George: Well, it started with the need to earn money, I suppose. Coming from immigrant parents, it’s probably an important thing to do. But I started as a foreign exchange trader at Citibank, and moved on to the mortgage-backed securities area for a number of years at Merrill Lynch. I also ran risk for a large macro hedge fund, and then was one of the founding partners of hedgefund.net, which is one of the first digital platforms for hedge funds. And then spent time at a group called Mercury Capital Advisors, where I was a partner, and that was a large placement agency for private equity and hedge funds.
So, I’ve been with FolioBeyond for about two years. And FolioBeyond was founded in 2017. And it’s, we provide solutions, and we manage money, that integrate factor-based models. And that’s basically risk models, looking at correlation, looking at stress testing. And we constrain our models depending on the risks that our customers want. In late 2021, myself and my partner sat around and said, “You know what? Times have changed.” We see inflationary problems on the horizon. We believe that the Fed was going to attempt a more responsible approach towards interest rates, because we were, at that time, staring very close to zero interest rates. And we developed an ETF, which is, in a way, really a liquid hedge fund, but it’s an ETF that rises in value as interest rates go up. So, our returns in 2022 were 33.6%. And towards the end of 2022, we increased our dividend from about 4% to 7%. So, we have a 33% return, we have no correlation to the bond…or very low correlation to the bond and stock market, and we provide a 7% dividend.
Andy: So, George, I’ll just stop you there. You and your partner, are you lucky that you have very good timing, or are you both geniuses, or is it a combination of you’re lucky and you’re geniuses?
George: Well, yeah. So, my partners are very well-seasoned as well. Yung Lim, who’s been in the market for 35 years, he’s our CEO. And Dean Smith, not the basketball coach, but Dean Smith is our strategist, and he’s our chief marketing officer. And he’s the one that’s been managing a lot of what we’ve been doing. And we have a chief administrative officer called Neeraj Parasher. So, the four of us really sat down and thought very hard about it. I don’t think we were lucky, but luck always does play a part in it, specifically the quickness with which the Fed raised rates. And what we found very interesting is that people were still living in a ZIRP world, zero interest rate world, and they didn’t believe that the Fed was serious. They thought that the Fed would always go back to a QE type of methodology.
Andy: George, aren’t they still there? I feel like people are still there. They’re still thinking it’s just around the corner. We’ll be back there.
George: Yep, yep. You hear on, you know, all the major, you know, broadcasting out there, CNBC, Bloomberg, you hear about, “Yes, it’s around the corner.” And I call them pivot-seekers. These are people who have a hard time dealing with a rising rate environment. And what we’re trying to do is establish a normalized yield curve. There’s no reason for our interest rates to be lower than inflation for as long as they have been. And people will, you know, cut and divide and look at different statistics. But we still have 6% inflation, as the CPI numbers came out today, and our 10-year treasury is at 3.8%. Now, the average 10-year yield over the last 50 years, if you take out the Volcker years, is probably about 4.6%. If you put in the Volcker years, you have about 6.25%. So, we’re looking, and we always believe that you’d get a normalized yield curve, where savers, who were disenfranchised the last 50 years, can come back into the market.
Andy: Well, that’s interesting to me conceptually. I mean, I was born in ’83, and I just take it as a fact of life that unless I take on a substantial amount of risk with my investable savings, that Uncle Sam is gonna tax the living you-know-what out of me in the form of inflation. And, you know, even talking about those, the 10-year yield of let’s say 4%. Well, if it’s not in an IRA, I’m paying taxes, right? I’m paying taxes even on that gross nominal yield, which isn’t even positive in real terms. It’s already negative in real terms, but then I still have to pay taxes on it. So I almost take it as a fact of life that I’m gonna be losing money every year if I’m invested in 10-year treasuries, and even, frankly, probably corporate, like, high-quality corporates maybe is where I begin to eke out a positive return. Are my expectations wrong? Do I just have, like, Stockholm Syndrome from, you know, being the age that I am?
George: Well, I think that your generation certainly knew nothing but a Fed backstop. The Fed would cure all ills. But there’s no doubt what you say is true. Inflation is the great destroyer of wealth. And it has been, and it is right now until we get a more normalized yield curve. So, when we saw that there was a definitive move by the Fed towards QT, and we saw, and what we believed we were in or entering, a secular bear market in bonds, these things are not, you know, resolved in a year or two. We thought there was gonna be a long-term approach to it. And by the way, as you said earlier Andy, the fact that people are still looking around the corner for the pivot tells me that this is gonna be a much longer-term play. So that’s why we developed RISR, R-I-S-R is the acronym for the ETF, that has produced some very, very good results.
But more importantly, it’s a diversifier. There’s not enough diverse portfolios out there. And if I may just quickly go into, you know, I was looking at some statistics, and I saw, you know, what percentage of uninsured deposits SVB had. It was 82%. The cost of interest-bearing deposits was highest in the industry, and the percentage of securities with 10 years or more duration was as high as 79%. Having said that, it’s important to note that there are other regional banks and even some major banks that have statistics not that far from that.
Andy: Now, are they… Okay. And wanna talk about Silicon Valley Bank. Are those, I guess, are those banks in trouble? I mean, wasn’t the whole point of Dodd-Frank they have to, like, mark to market? So, is there transparency around this issue? Is it hiding in plain sight? Like, does anybody besides George know about this? You know, or…
George: I think the management knows about this, but the management basically was irresponsible at SVB. They were speculative. And I’m not very enthused about this lending facility program that they put up, which basically means that they can put up their collateral of their bonds at par value. So, they have 1.5%, 2% bonds. And now the interest rate’s 3.5%, 4%, but they still get 100% on the dollar for that, despite the fact that the price of those bonds have gone down. That, in a way, is a, you wanna call it a semi-bailout, that’s fine, but it’s close to a bailout in many ways. And there are numerous other banks that have these kind of problems with length of duration in their portfolio, the cost of interest, and uninsured deposits. These three banks, Silvergate, Signature, and SVP, are certainly not alone. And the numbers are out there right now. People should be looking at the numbers and asking questions. Why haven’t, something that could so simple to do hedge interest rate risk? Why hasn’t it been done? And it’s…
Andy: Well, it’s interesting. You know, your logic, it’s a little bit…it’s not really contrarian. Right? Like, the logic that you’re using, I’m like, well, no, that’s just common sense. And I was asking, you know, kind of joking a little. Is your timing lucky or are you a genius? But the fact of the matter is, you almost don’t have to be a genius when yields are virtually zero, or they’re highly negative in real terms. And, I guess, let me pat myself on the back, because I’ve barely even recognized that I’ve done this. But about two years ago, I brought all the, my allocation to bonds down, across all my portfolios, with index funds or ETFs. And honestly, for a long time, I’ve been in short-term, you know, two, three-year municipal bonds, because I just didn’t see any point to getting in 100 basis points more of yield or whatever to take on all of that risk. And it’s like, whether it was a medium-term, short-term or a long-term, it’s like the yield’s all negative. Well, I’m not taking the risk then to earn another 50 basis… So I’m like, I’m not a genius. That’s just common sense.
George: But you can have a side business as a consultant to all these regional banks.
George: They would have listened to you. You know, we feel sometimes like we’re really just, you know, hitting our head against a sidewalk. Please, you know, one way or another, hedge your interest rate risk. You know, the phrase, “Don’t fight the Fed” didn’t mean just when rates were going down. It also means don’t fight the Fed as rates are going up. And there, it seemed intent…they didn’t seem intent at the beginning, the first six months of last year, but they seem intent right now that they’re gonna squash inflation, or, as they put it, break something first. Nothing’s broken yet. Now, this SVP, Signature, and Silvergate…
Andy: Well, let’s talk about that, because in my mind, Silicon Valley Bank, it could be a game-changer. Like, the one thing… I agree with you. They are between…the Fed was already between a rock and a hard place. And I agree with you. They basically said, “We’re gonna beat inflation…we’re not gonna fully beat it. We’re gonna at least get it back into the fours. We’re just gonna get it back to 4.5% or whatever, and then we can kind of squint and say, ‘Well, we mostly beat it. Job well done,'” whatever. But, I think the one thing that could change their calculus is if people start to feel like the entire financial system now is shaky. That’s gonna override, potentially, and I’m not saying we’re there yet, but if we did get to that kind of a point, where people are fearing systemic collapse, doesn’t that just override everything else from the Fed’s point of view?
George: It does. If you’re putting it in that kind of cataclysmic type of area, you’re absolutely right. But let’s back up a little bit. This is a people business. The CEO of Silicon Valley Bank pressed Congress very hard in 2018 to loosen regulations. Let’s begin with that. He also, by the way, sold a bunch of his equity in February. Now, this collapse happened in 2 or 3 days, and it was obvious why it happened. You know, you just have to read the papers. But yeah, I think that the Fed, if the Fed would raise the…if the Fed was not to raise this month, a zero, they would show an absolute no-confidence vote in the economy. Twenty-five basis point, they’d say, “You know, I’m a little worried.” Fifty basis points, say, if they were to raise 50 basis points, they would say, “We feel strongly that the financial system is in good shape.” Frankly, they should probably do 75 basis points and wait, but they’re not gonna do that. They have so much political pressure coming on them from different members of Congress, Senate, etc., that they’re gonna, you know, try to find, again, try to walk a fine line.
Andy: You’re talking about the political pressure on them is to whip inflation?
George: I think the political pressure on them is not only, on one side is to whip inflation. On the other side is stop breaking things by raising rates. I was reading, Andy, I was reading a well-known economist from a well-known university saying, “The Fed should do an analysis on what 25 or 50 basis points would do to certain banks’ balance sheets.” Really? Is it their job to do that? It’s the bank’s job to protect themselves from rising rates. And there’s numerous tools with which they can do that.
Andy: Well, George, it’s easy. We just need to give the Fed seven different mandates, and have them pursue all seven mandates at the same time. Totally simple, right? I mean, it’s…
George: Exactly. Exactly. Their job…look, their job is financial stability, quash inflation, get back to running the business the way they expect the rest of the banks to run their business, and that is, in a much safer way. Not a speculative way. By the way, just doing nothing, that so many of these banks, so many of these RIAs with their investors’ portfolios, I call it portfolio malpractice. You know, all you have to do is move your duration down to one or two years, like you did. You moved into municipal bonds, one and two years. That’s fine. We’re not saying to have zero duration. I mean, that’s my ultimate recommendation, given what I see going forward. But you have to really assess who these people are who are running these banks. And it’s very disappointing to see that in 2023. I felt like I was in the 1980s again.
Andy: Well, is this… Okay, let me make the, maybe the devil’s advocate argument, or maybe the bull case for bonds. You know, bonds have taken a big hit. They’re down, you know, big. You know, yields are way higher than they were.
Andy: So, isn’t this the time when I should be buying bonds? I mean, it’s actually the first time, literally the first time in my life when bonds are, like, even conceptually… And again, I guess I have to ignore inflation, which I can’t, but where bonds are even in, like, an abstract sense, desirable at all. Previously…
George: Yes. Yes. In an abstract sense, I think you’re right. But I have papers that I have saved over the last year from well-known money managers, well-known RIAs, who are saying, “2.75%, a great time to put your money into 10-year treasuries. At 3%, this is a great time to put your money in 10-year treasuries.” Same at 3.5%. Just do it. Four percent, corporates. I think we’re going a lot higher, for a lot of different reasons.
Andy: So, you’re saying, no, Andy, maybe you wanna wait for 9% or 10% yields, and then that’s the real buying entry.
George: I don’t know about 9% or 10%, but, you know, we don’t have Volcker in the hot seat right now. But I think that, you know, the number that nobody likes to talk about, 6%, is very real.
George: The six number, I call them.
Andy: So, how long can this last? You know, if we are in a secular… Was it…would you… Okay. First of all, was it fair to say we were in, like, a 40-year bull market for bonds, roughly?
George: No doubt about it. Absolutely. We had bumps along the way, but it was a 40-year bull market. We had ’94, ’99. Couple of times, retracements, but we were in a 40-year bull market. Secular bear markets or secular bull markets are not a two or three-year period. I think we’re in for a more sustained period of time. We’re not gonna see a reversal. And when the Fed says, “We’re going back to two, you know, our goal is 2% inflation,” what they don’t say is how long it’s gonna take to get there. Now, there’s a Bank of America longitudinal study that looked at once inflation pierced 5%, and you can get that online anywhere, they said it took up to 10 years to get back to 2% inflation. Well, we’ve pierced 5%. We stayed there. And, you know, it’s amazing to me, and when I watch the CNBC or Bloomberg, they’re always parsing the data, looking for the positive, which is fine. And I guess they’re playing to their audience. The audience wants something very positive to hear about. But they have to be realistic as well. It’s okay…
Andy: Yeah, yeah. George, I mean, can this bear market be 40 years? I mean, and also, the assumption that we get back to 2%, I mean, I can see tightness in the labor market lasting until I am a great grandfather, or frankly lasting beyond that, with some of the structural issues, educational issues, demographic issues. I don’t really see that going away.
George: I’m glad you brought that up. I thought I was the only one that believed that. I think we’re seeing a resurgence of labor in this country. You’re seeing it around the world, whether it’s, you know, pockets of Starbucks trying to unionize, or, you know, McDonald’s workers asking for $22 an hour. And by the way, if you were to inflation-adjust the minimum wage from 1968, when it was $1.60, it should be, just inflation-adjusted, it should be about $25 an hour. And going back to this inflation-adjusted, last time I saw the FDIC guaranteeing deposits, in 1980, it was $100,000. They’ve moved it to $250,000, you know, a decade or two later. From 1980, at $100,000, today, they should have adjusted to inflation to be $400,000.
Andy: Well, and you know, that’s interesting that you mentioned the minimum wage. You said 60 is, I think… But I’m thinking.
George: 1968, it was $1.60. It should be $25 today.
Andy: Well, going back to that, you know, those years, and the baby boom, you know, we had a birth rate in the United States of whatever it was, high twos. Three, high twos, and then 2.5 or whatever. Well, our birth rate now is 1.6. Maybe I’m thinking, like, too long-term. I know we have inflation, or excuse me, immigration, which is good for the labor market to, you know, ease some of that pressure. But the fact of the matter is we’re not really replacing our workforce, as the workforce retires and ages out, in many cases, we’re not replacing those workers with other skilled workers. So, that’s gonna create upward price pressure on wages, I would think. And, I mean, I think we’re seeing that…
George: Oh, you’re right. The only thing that could stop the demographics that you could describe, of lower birth rates over the last couple decades, and looks like going forward, is immigration. That might ease it a little bit. But we have a demographic change in this country. And asked, going back to whether this bear market in bonds can last a long time, you know, I could see it lasting 10 years. I don’t know, you know, after 10 years, you know, who knows what’s gonna happen in life, but who knows after one year? But I think it’s a much longer-term period of time that we’re gonna see this and deal with it. And once the pivot-seekers, you know, decide to stop, you know, proselytizing on TV, I think that a lot of these banks and a lot of these RIAs will get serious about their portfolios. I don’t know any RIAs that made money last year, and they’re very proud of the fact they’re only down 8% or 10%. That’s not the world I was raised in. You know, I was raised in a world of absolute returns, and there’s a lot of things they could have done to make money. People don’t believe we are up 33.6% last year. But just look at Morningside. We’re there.
Andy: Well, top-down… George, I’m not an RIA, but let’s pretend I am. Let’s say I’m your RIA friend, we’re at the bar, we’re having a beer. You know, obviously, RISR, the ETF, but, from a top-down portfolio construction perspective, the next, let’s say the next 10 years, or the next 8 to 10 years, we’re in a secular bear market. How does it change my portfolio construction?
George: So, that’s a very good question. So, we have, we’ve constructed RISR, R-I-S-R, to be a negative 10-year duration. And that basically means that rates rise, the value rises. So, what we’ve done is taken mortgage IOs, interest-onlys, pieces. So, a mortgage is a principle, as well as an interest. We have taken the IO piece and mixed it with treasuries to make a negative 10-year duration. So, when you have a negative 10-year duration, it’s pretty easy to figure out how much of your positive duration. And most of the portfolio that I’ve seen out there are between 6 and 8 years of duration, which is high duration. That’s like, that’s basically a duration of a 10-year treasury.
And you try to…and with that, you can move down your duration to three years, two years, one year, where you’re comfortable. If you still got a little bit of bullishness left in you, you know, you might wanna leave it at three years. You know, I have no bullishness left on me, as far as the bond market is concerned, not least for the foreseeable future. And I don’t think that… And by the way, as you pointed out, you know, the tight labor market is gonna be the underlying problem that we’re gonna have with inflation going forward. I’m not saying that’s good or bad. I’m not making a political judgment. But, you know, people aren’t gonna be working for $9, $10, $12.
Andy: You can make the political judgment either way. You can make, you know, I mean, you can blame 10 different things for that issue. But your point is it’s now part of the backdrop, and it’s going… Unless we wake up tomorrow and suddenly everybody wants to go to trade school and become a plumber or become a skilled electrician or engineer, this problem is gonna be with us for the foreseeable future, the end, period, goodbye. It’s just, it is.
George: I think that that’s correct. And I think what you’re also gonna see… You know, so, if in fact you see the Fed backing off a little bit, you’re going to see the market understanding that they’re going to be very careful for the next six months. So all of a sudden, the yield curve, which is inverted, is gonna revert. So you’re gonna see a steepening of the yield curve, which you’ve seen over the last few days, to a substantial amount, which means that we see inflation being a much longer-term problem. That’s just not a one or two-year problem. And that’s what I think you’re gonna see. That brings us a normalized yield curve, where you have maybe 4% on the two-year and you’re gonna have 5% on the 10-year. So it’s gonna be a positively-sloped yield curve, which really is gonna manifest that we’ve all admitted that’s gonna take a little bit longer to cure the inflation problem that we have in this country, and in fact, in this world.
Andy: Okay. You know, I wanna ask about interest rates in relation to treasuries. And, you know, the 2-year or the 10-year or 30-year. Because, again, I think maybe I’ve just, the era in which I’ve grown up, this is all mixed up in my head. If there’s a neutral inflation rate, and a neutral 10-year rate, and a neutral 30-year rate, is inflation supposed to be lower than the 10-year? And then the 10-year is obviously supposed to be lower-yielding than the 30-year Is that, would that be normal?
George: Yes. And that’s basically known as real positive yields.
Andy: So that’d be, like, what, 3%, 5%, and 6%, 3% inflation, 5% 10-year, 6% 30-year? Would that be, like, what normal is?
George: It would be. And nobody…
Andy: Well, wait. I mean, when are we gonna see normal? I feel like I could live to 100, age 150 and never see that side of circumstances…
George: Well, let me give you an example. Let me give you an example about my immigrant father. In 1978, he was doing well and he bought a second house. And he…1978. And he was very proud of his 8% mortgage. A year and a half later, he was even prouder of his 5-year 12% CD. Now, you tell me where you can do that kind of an arbitrage today. You don’t see it. He had an 8% mortgage, which we think is ridiculously and astronomically high. But he put his money in a 12-year bank CD, 12% return. Now, I’m not saying we gotta have that kind of relationship…
Andy: And that’s what I’m saying, George, is, like, I’ve never heard of that. Like, that’s, I don’t think that they’re ever gonna let me, or let investors, or let you, I don’t think they’re ever gonna let us have that again, where they’re not gonna tax us with inflation at a higher rate than they will give us.
George: Yeah. Well, that’s gonna have to change as soon as we have these bubbles pop all over the place. Tech bubble popping. You know, mismanaged regional banks.
Andy: Is that popping in real time? Do you see both those things popping right now? Venture capital, tech bubble, regional banking bubble, are those all… I mean, venture capital, obviously valuations are already down somewhat in the last year.
George: Yeah. I do. I don’t quite see popping a bubble. I would call a slow release of the air from the bubble.
Andy: That’s given me a…okay. Yeah. I got an image of that. Maybe we can get our producer to add a sound effect. But okay, so, the air is slowly being released from the tech bubble. Is that happening?
George: It is. Yeah. And I think that a good part of it has been the way Jerome Powell has spoken about things. He’s been, you know, walking a very fine line, talking about 2% inflation again. At the same time, we’re very tough on, you know, being careful that we’re dealing with a very tight labor market. So, he’s talking about a lot of things. He’s gotten a little bit stronger, incrementally stronger, over the last nine months. And I think that people have still not quite believed him. They still believe there’s gonna be a pivot. In fact, I’ve seen reports that they expect rate cuts later this year, rate cuts later this year. Forget about stopping, with rate cuts this year. So, again, if he does nothing, he shows…if he does nothing in March, that tells me he’s got absolutely no confidence in our financial system. If he does 50 basis points, he has some confidence that this was a passing problem with several regional banks, and let’s move on.
Andy: Well, you know, I think I have confidence in the sense that I think whatever happens, there would be a backstop or a bailout or whatever. I mean, I just, I think politically, that’s my assumption. Am I wrong in that assumption?
George: Well, I think that’s a very good possibility. But at the same time, that’s going to put a lot of wood in the fire for future inflation. This is, you know, I see more of a stagflationary environment than a deflationary or inflationary robust economy. Right now, I mean, we got 3.7% unemployment. That was unheard of 25 years ago. The 4.5% was normalized. That was good. It’s okay to have a 4% unemployment, 4.2%, except for everything has gotten so highly politicized. Every movement, every, you know…
Andy: Well, I mean, in fact, isn’t there an unemployment rate that’s, like, too low? Like, we need a little bit of give and take in the labor market, or that actually constrains economic growth and…
George: No doubt about it. Absolutely. Absolutely. So, you know, and seeing the move from 3.4% to 3.5% to 3.7% to 4%, I think is gonna be fine for our economy. Moving interest, keeping interest rates at a sustained level, or maybe keeping them above inflation at some point, is gonna be okay. And I’m not talking about rate of change in inflation. I’m talking about the actual inflation rate. It’s 6%. It’s not talking about the rate of change, which we always hear these economists parsing. It’s gotta be higher than inflation over time. And I hope it’s done over the next year and a half or two years. It’s gonna take some time to be able to get used to it. And by the way, I heard enough people saying that our economy will be crushed if the Fed moves rates up 200 basis points. Well, they moved up 400 basis points and we’re going gangbusters.
Andy: Yeah. And, you know, frankly, it’s one of those things that, you know, if I say life’s not fair, it’s not fair, this, that, or the other, I have personally felt that asset prices have been gamed or manipulated for so long. This may sound crazy. It’s almost like I don’t care about my own portfolio. I just wanna, like, I want the market to discover the price of things again. And not that I’m an altruist or whatever, but I think that would help middle-class people if the market could discover what the price of a house, a single-family residence, actually is, if the market could discover what the price of the S&P actually is, the market could discover what the price of a 10-year bond actually is, without being manipulated, I sincerely think that we would all be better off.
George: I couldn’t agree with you more. Couldn’t agree with you more. In fact, I get a lot from my kids, who are in their early 30s, and says, you know, “Yeah, you boomers, you bought, you know, shore houses and mountain homes for 11 raspberries. You know, we got 12 guys in an apartment in New York City paying, you know, $10,000 a month.”
Andy: Well, and yeah, but you went to college, you paid your way through college for $300 a semester, tuition, or whatever, right. Like, it is, it’s kinda true. If those goods and services have had an inflation rate of 9% for the last 40 years, it’s like, it just isn’t…
George: Yeah, college education has gotten totally out of hand, and it’s become only for the wealthy, despite the fact that universities say half of our endowment is spent on financial aid. Probably 100% should be spent on financial aid on some of these very… There’s this one university, I won’t mention the name, but it’s got a $12 billion endowment. And I asked my son, listen, why don’t we set up a small little endowment for XYZ? He goes, “Dad, if this university was to pay for every single student, they’d still have a couple billion dollars left over the next 30 years.” So, you could pay for every single student going to school for 30 years, and you’d still have $2 billion left. And by the way, we also…
Andy: Let me guess their endowment’s no longer taking donations, right? They have enough?
George: Oh, yeah. No. No, no. You know, the three times a day telephone calls to come in.
Andy: Yeah, yeah. So, okay. You know, I love it. I love that, just, your reality-based viewpoint, and the fact that you and your partners were contrarian a couple years ago. And it does feel a little, maybe you can empathize with us, sometimes I feel like I’m the one taking crazy pills. You know, if I underwrite a deal… I’ve even said this to my business partner before, I underwrite a deal. And I said, “Am I taking crazy pills? Like, what am I missing here? How does this make sense?” And, number one, you know, interest rates being manipulated. Like, they’re not necessarily market prices. And then other actors in the market may have a different calculus. So, I love that you all, you know, you’re using simple logic, though, because when you talk about the theory and the thesis behind RISR and behind the strategy, it actually, to me, just sounds like common sense. But how, I guess, you know, you mentioned, it’s not that hard to hedge interest rates. What is it…you know, what should banks be doing? What should family offices be doing? How do, aside from buying RISR, and I’m not telling anybody not to buy RISR, but aside from doing that, could you walk us through how should a family office, how should an institutional investor, or even just a regular high-net-worth investor, how should they be hedging against rising interest rates with their own portfolio?
George: Let me begin by saying that it’s really critical that these family offices, and there’s some very brilliant family offices out there, and some RIAs, brilliant RIAs out there, they know they have to reduce the duration of their fixed-income portfolio, specifically when the Fed is sticking a finger in your eye and telling you that’s what they’re doing. One thing they should do, there’s a lot of ways of doing it. They can do it through option-based strategies. They can do… And, but the option-based strategies that exist out there have negative carry. Don’t forget, they have decay. That’s an issue they have to look at. Again, the upside and the downsides are much greater. Some option-based strategies were making 60%, 70% last year.
Andy: And George, I mean, conceptually… I’m not a finance whiz, okay? So take everything with a grain of salt. But conceptually, like, just the costs, transaction costs, and even just the headache of dealing with options or whatever, that’s why with my own portfolio, I just decrease duration and I’m like, you know, like, I…
George: That’s a way of doing it. Look, the option-based strategies are, you know, you have to get very sophisticated people, and they are out there. Then there’s the strategies that have, are holding, you know, TIPS. I’m not sure why you’d pay anybody to hold TIPS for you. And then there’s those strategies that are buying what they perceive equites that would do very well in an inflationary environment, whether it’s mining stocks or commodity stocks. And that’s another way of doing it. The problem with the latter is that you’re going to have a high…if the market decides to go down 10%, 20%, every stock’s going down.
Andy: Well, and, like, REITs, for instance, I’m a big REIT guy, but those are very volatile, right? They are a pretty good hedge against inflation, but you’re gonna go on a wild ride, right?
George: You are. I have a chart, I’ll send it to you after our discussion here today, about how RISR would have been the perfect hedge for REITs over the last year and a half. And you wouldn’t have lost any money. REITs haven’t done that well, and I have to tell you that, over the last period of time. But yeah, over the last 30 years, it’s been a great investment. But now we’ve got QT. We’ve got a different environment, and nobody wants to accept that. Or few wanna accept that. And they’re going to have to at some point. And then, by the way, this, the SVB fiasco, I can tell you, there’s gotta be regional banks out there that are real worried that people are gonna take a much closer look at them.
Andy: So, if I bring…conceptual question. Whether I buy RISR itself, or maybe there’s a way a family office or institution can use a similar kind of strategy to do something similar, am I purchasing bonds, and then another security or something that’s hedging…
George: Well, you’re buying an ETF, which is daily liquidity, backed by IOs, AAA, by the way, Fannie, Freddy, and Ginnie. We only deal with the AAA agency IOs, and mixed with treasuries, to adjust the duration to where we think it makes sense, which is a minus 10, minus 9-year duration. And you buy that ETF. The IO market, by the way, is highly liquid. So that’s not an issue, and that’s why we can get out of it.
Andy: So, how much yield…I guess, how much, you know, of, like, the, what’s the cost to bringing the duration down to zero? Like, how much of the gross, you know, long-only yield are you…
George: So, it depends on how big your portfolio is. But, you know, minus 10-year duration is pretty easy to figure out if you got plus 10-year duration. So you buy 100% against it and you’re down to zero, or whatever ratios you look at. So that’s an easy, easy call. But I think that what individuals or RIAs, family offices should be looking at is a certain percentage of their fixed-income portfolio should be in RISR. And by the way, it’s also, has extremely low correlation to equities. We have a long-short equity fund call us and said, “You know what, I just bought some of your RISR because, you know, you’re not correlated, and I’m worried about the stock market, and made sense to me.”
Plus, he’s getting a 7% dividend. The reason he’s getting 7%… We started out with a 3% or 4% dividend. But as rates got higher, we’re able to, you know, leg into higher interest-bearing mortgages. You know, they’ve got up to 6% or maybe 7%, bought them at a discount, and we’re able to produce a 7% dividend. I’m not sure we can get no correlation to bonds, or little correlation to bonds, no correlation or little correlation to equities, 7% dividend, and you’re protected from your house burning down. You know, you have home insurance. Why wouldn’t you have rising rate insurance? I don’t know. Am I being a little too simple and maybe too self-centered about our product? Probably.
Andy: No, no. It’s all right. No, I, you know, when I have a guest on, if you don’t talk your book, I’ll be disappointed. I mean, we expect it. But I have to imagine that this ETF is, you know, your timing, you know, again, I don’t… Lucky, genius, good timing, whatever we wanna call it, but it has to have had some serious traction in the past.
George: Our timing was very, very good as far as bringing this ETF as a offering to the community. The community was not totally ready for it, because they didn’t believe in the interest rate rise. I believed in it because I knew that at some point in life, you had to have inflation lower than your returns. You had to have that 8% mortgage and a 12% bank CD at some point. Not quite…
Andy: Gravity, or the gravitational pull, or whatever you wanna call it.
George: Yeah. And so, the market wasn’t ready for it. The market didn’t believe it. The pivot-seekers were crawling all over CNBC and Bloomberg, and, you know, the people listen to these guys. You know? I’m thinking about having a ETF that goes against what they say in the fixed-income markets.
Andy: Well, George, I mean, how long does the market…how long do you have to wait until you and your team get to take a victory lap? You know, I mean, you’re basically telling me after your returns last year that the world is still full of doubters and…
George: Yeah. I am. And I’m not sure how long they can wait it out. But again, if you look at some of these banks, and you look at their percentage securities over 10%, I was stunned. Andy, there’s a chart I’ll send you after this that these regional banks have higher percentage of securities over 10 years than Silicon Valley Bank. They have higher uninsured deposits than Silicon Valley Bank. This is, you know, now, they had a $42 billion run in one day because people needed money. Now, I don’t think people need money in these other regional banks as badly as they did, you know, with the private equity and their venture capital.
Andy: It’s like, do these banks even have a chief risk officer or a portfolio manager? I just don’t understand the logic that would make you say, “Oh, the 30-year is yielding 4%. Let’s buy a bunch of 30…” I mean, it’s just… I don’t get it.
George: I don’t know if they do. Well, they do, in theory, but, you know, we were at a conference in Charleston in December, myself and Dean Smith, and we were stunned. These are highly sophisticated money managers, all said, “Well, my research team says we peaked in rates,” or “My research team sees a pivot in 2023.” I’m not saying that’s a stupid opinion, you know, or an uninformed opinion, but it was amazing to me that despite the Fed signaling what they’re going to be doing, they still had this way of managing money through hope. So, if you’re asking what I’m seeing and why we can’t take a victory lap? Because people are still managing on hope. And I think that’s one of the…we can take a victory lap on our returns. But we can’t take a victory lap on really convincing people.
Andy: Well, you know, maybe I’m thinking too…I’m too backwards-thinking. But I would say the point in time where we are now, I am more agnostic. I’m not arguing with your point of view, but I am more agnostic in the sense that, you know, when inflation is at 6% or when interest rates are at 5%, it’s more plausible to me that they can go up or they can go down. When yields are at 2% or 1.7%, it’s just not really plausible to me that they can go lower. So that’s really what I can’t…I can’t really get inside of that logic, where you’re saying that yields are…
George: And that’s hindsight, you know. But there were people, when we were at 1.6%, 1.7%, who thought we were gonna go lower.
Andy: Yeah, maybe a little bit. But what, you know, it’s just, it’s risk and reward. How much juice is there really to squeeze when you’re at a 1.7% yield? You know, that’s the logic I never understood, was the…not that it couldn’t go lower, but just the risk-reward. Now, if you’re at 5%, if you’re at, whether interest rates, inflation, you’re at 5% or 6%, it’s just more plausible to me that it can go up or it can go down, you know. But it just felt to me like we were really, unless we went full Japan, it just felt to me like we were at a floor or ceiling, depending on however you look at it, but…
George: Yeah. Well, I mean, that’s logical, I would say. But let’s look at a different way. You know, we were talking about demographics. We were talking about tight labor market. We were talking about the re-unionization of America in many respects. So, let’s talk about just sustained inflation for a while, and interest rates being sustained for a period of time. Maybe they don’t go to 8% or 9%, but maybe they do go a little higher, maybe they do go a little lower. But, you know, that’s like saying the value of your house goes up, value of your house goes down. You’re not gonna change the insurance premiums on it, or how much you insure your house for because it’s gone down $50,000. You’re gonna keep it at whatever level you have, and you’re gonna pay that every year. It’s house insurance, from your house burning, being swept away. And by the way, you’re gonna still live in the house. And it’s okay that you’re not making that extra bip or two. So, I look at it as an insurance policy with a 7% dividend.
Andy: It’s a pretty good insurance policy that pays you 7%. So, let me ask, and I know we’re running short on time, but I love that this product… I love products. You know, it’s the marketing guy in me. I’m really a marketing guy in heart, who just happens to be in finance now.
George: You’re a municipal bond consultant. Okay?
Andy: Yeah, that’s right. No, I’m, by the way, any regional banks or any bank at all…
George: I’m gonna put them to you.
Andy: Yeah, yeah. Totally. Shoot me an email. I’ll consult. You know, 200 grand an hour, whatever. Whatever is a fair rate. But talking about, as a marketer, I love that this product has a very clear, simple thesis, and then how that thesis plays out. It’s like, if this is the right bet, or, you know, you’re buying insurance for this circumstance, and if it’s circumstance pays out, it’s gonna pay off handsomely. And as you say, it’s paying a dividend to you in the meantime. Do you and your team have any other theses that you believe that you might be testing, you know, other products, other types of products like this, that are built around, you know, specific ideas, specific bets? Are there plans to sort of add to the ETF family?
George: Yeah, yeah. Well, we do. We have a fixed-income model that we are talking to numerous institutions about, with 23 subsectors of ETFs, from everything from high-grade corporate to REITs to Treasuries to RISR being in part of that fixed-income model. And that has done very well as well. It hasn’t done as well as RISR on its own. We also are not believers in being fully long or fully short anything. We, again, believe in diversification, lowering your duration, and we hope to be coming out with a AI, machine learning long-short income dividend fund at some point this year as well. So, that has also, again, numbers going, back-tracking, or back-testing numbers. I’m not a big believer, but back-testing has done very well on that. So, we hope to get that. But we’re focusing right now on the fixed-income model portfolios, and RISR being a part of that, or look at RISR, how that would fit into your portfolio on a 10% or 15% basis, to reduce that duration that you have, to protect yourself from interest rates while getting a 7% dividend. I guess, kind of, I don’t know, it’s… Am I the one that’s crazy?
Andy: No, no, you’re not. You know, like I said, I wake up and half the time when I’m talking about this stuff, I think I’m the one taking crazy pills. But as a marketer, I would say, I think FolioBeyond, RISR, you all are in a good spot because you have the economic news every day going out there and doing your marketing for you. Right? And your thesis can play out in real time on the front page of “The Wall Street Journal.” And so, again, I just love it when a product has a clear thesis and a clear mechanism for that to reward investors. I think just that simplicity, something, as a marketer, but also as a finance guy, that really appeals to me. And so that being said, George, where can our audience of high-net-worth investors and family offices and advisors, where can they go to learn more about FolioBeyond and about RISR?
George: They can go to our website, or they can go to the, just, contact me. One thing we pride ourselves on is getting back to every single question, high-net, low-net, individual and to discuss our product. You know, we respond immediately to everybody, and we’re happy to talk about them. So, you just put RISR, you just google it, and you’re gonna get a bunch of information on a bunch of charts. Or go to foliobeyond.com, and that also gives you a full array of everything from prospectus to information on RISR, and, but, you know, people like to talk to people, and I’m happy to sit down and talk to anybody, and we’ve gotten quite a few phone calls, you know, from high-net-worth individuals who aren’t major investors, to institutions who are thinking about saying, “Can I buy $50 million of this at one shot?” I mean, yeah, you can. You can. You know, but we haven’t quite seen that guy buy that $50 million piece yet. But this is something that, you know, in the days of, you know, in the late ’80s, early ’90s, it was swinging it around, those kind of numbers. So, it’s a liquid market. We’ve just managed to put this into a liquid market. We managed to put a hedge fund that hedges your interest rates rise in a liquid ETF. And I think that’s what the success has been.
Andy: Totally. Yeah, no, and it’s scalable. And as I said, I think you’re gonna have a lot of good marketing fodder, not only with Silicon Valley Bank, but just in the next couple years. So, George, I can’t thank you enough for coming on the show today. I’ll be sure to link to both the FolioBeyond website as well as I’m gonna link to this ETF, RISR, the ETF page. Maybe I’ll even put a nice little chart, show your return from last year…
George: That’d be great.
Andy: …to basically say, “Hey, that’s a little victory lap for you.” We put in the chart in the show notes. That’s gonna be your victory lap.
George: Thank you. And what I would, you know, I would concur with you, from what we said at the beginning, this Silvergate, Silicon Valley Bank, and Signature Bank, I think really has the potential of exposing some problems out there. So, you know, we’ll see. I don’t see any more runs on the banks, but to a great extent, these three banks were a canary in the coal mine, and now people should know they can’t go much further.
Andy: Totally. Canary in the coal mine. You heard it here first on “The Alternative Investment Podcast.” George, thanks again for joining the show today.
George: Andy, thank you so much for having me.